March 5, 2014 -- Cars are the second-most-expensive things that most people buy, and can be one of the greatest impediments to achieving financial security. There are myriad traps involved in deciding whether to buy a new car, negotiating its price and financing and insuring it.
Falling into these traps can be extremely costly and drain resources that could go toward other things, like college savings for your children or investing for your retirement.
Here are some of the deeper traps and the best routes for steering around them:
• The gotta-have-a-new-car-now trap. Many people itch to have a new car as soon as — or even before — the old one is paid off or the lease expires. If they act on this compulsion and get a new car, they continue to make payments instead of putting money toward other financial goals. Making the decision to wait for a new car enables you to save the money that would have gone toward a payment (for most people, $300 to $500 per month). This fund can ultimately be used for a cash purchase or, if it grows large enough, it might generate enough earnings to make or substantially diminish your payment when you get a new car.
If you drive your car for five years after your payments end — which, depending on how much you drive, can be a golden zone of no payments and few repairs — saving the would-be payment could result in a car fund of $20,000 to $30,000.
Of course, this means having the discipline to drive your current car longer, but cars tend to last longer (and cost more) than they used to. Any repairs could be paid out of the new-car fund.
I have a client who first contacted me when she decided to trade in her 10-year-old car. As a stay-at-home mom and part time realtor, she had been saving every dollar she earned from real estate sales, resisting the urge to buy the big fancy car as so many of her colleagues did. For 10 years, she slowly but steadily built up her car fund. Finally, the day arrived when she was ready to pay cash for her dream car.
But a funny thing happens to many people once they've saved a lot of money. We think about the sacrifice it took to reach this goal, and this makes us reluctant to let go of the money. This is one of the less talked-about benefits of committing to the discipline of saving.
My client had started looking at new cars, but was thinking twice about spending her new-car fund and having to start all over again. She called me from the dealership and asked if there was any way to invest the money to generate enough earnings to make all the car payments. After we ran the numbers and created an investment plan, that's what exactly what she ended up doing. Once the car was paid for, she had the car and the money. She drove that car for the next 18 years, letting her car fund grow and then using it to buy another new car.
• The price trap. Before you go to the dealership, do some research into the fair price for the car you want and the true value of your car for trade-in. Values for used cars and trade-ins for your part of the country can be found in a book serially published by the National Automobile Dealers Association (NADA) and available in bookstores. Negotiate the price of the car you want independently of financing considerations. Sometimes the salesperson will earn a commission on the financing of the car as well, so don't depend on the dealer to give you the best deal on financing.
The low-interest versus cash-back dilemma. Dealers often offer you a choice of lower interest rates or cash back — but sometimes you can have both. My client went to her credit union for low-interest financing and then chose the cash-back option from the dealer.
• The buy-versus-lease dilemma. When deciding whether to buy or lease, run all the numbers to determine the best deal. Sometimes leasing a car to eventually buy it may be the best option, sometimes not. It depends on the interest rates, how much you drive, the type of car and what manufacturers' incentives are involved.
Most dealers will try to sell you an extended warranty, but this often isn't worth the extra money. Sure, you don't want to pay for repairs, but you will pay dearly for the warranty. If you must have a warranty, then compare dealer prices with the comparable warranties offered elsewhere, comparing apples to apples to get the best deal.
• The low-deductible trap. When insuring your new car, make sure to run the numbers long-term on all the different deductible choices. Would choosing a $1,000 deductible save you 30 to 40 percent over a $250 deductible? How much would you save over the life of the vehicle by doing this? Do you have money that you could set aside in a reserve fund? If choosing a higher deductible saves you $200 a year, then after five years (of no claims), you would have endowed your high-deductible fund.
• The collision insurance trap. Unlike liability insurance in most states, collision insurance isn't legally required, though most lenders will require it. However, many people who own cars with paid-off loans and substantial mileage, but have retained their collision coverage even though their car isn't worth much. It makes no sense to pay several hundred dollars annually, year after year, for collision insurance on a car that's worth only a few thousand dollars.
For every aspect of car ownership, there can be a high price, and together, these prices can cut severely into your financial well-being. Avoiding these traps can help you keep these expenses down – and perhaps free up enough money each month to put toward your other financial goals.
This column is the opinion of the author and in no way reflects the opinion of ABC News.
Byron L. Studdard, a CERTIFIED FINANCIAL PLANNER™ practitioner, is founder and president of Studdard Financial, LLC, a fee-only financial advisory firm in Sarasota, Fla., dedicated to helping clients build wealth, protect it and pass it on to future generations. Studdard has been listed in the Guide to America's Best Financial Planners (published by the Consumers' Research Council of America, an independent research organization). He can be reached at Byron@studdardfinancial.com. If you have a question for him, send him an email and he will try to answer it in an upcoming column.